“Margin Call,” ABX, and Timberwolf

So far, the crisis of 2007-2009 has inspired several films. One was the outstanding documentary Inside Job, which is unique for focusing on the culpability of academic economists. Another was Oliver Stone’s Wall Street: Money Never Sleeps, a sytlized but flawed retelling of the collapse of Bear Stearns and Lehman Brothers. Back in May, there was the HBO movie Too Big to Fail, which purported to tell the story of the TARP bailout.

Now there is Margin Call. It does not tell the story of what happened in 2008, when big firms failed and governments used taxpayer money to bail them out. Rather, it tells the story of 2007. That was when some of the savvier players, particularly Goldman Sachs, discovered that the assumptions governing their risk models for U.S. mortgages needed to be revised.

The trailer provides a good summary of the action and the basic premise:


The only thing that is obviously unrealistic is the idea that anyone could save company data onto a USB drive, especially after having been fired. The other major flaw with the film is the title. There is no margin call at any point during Margin Call.

These, however, are slight quibbles.

Margin Call‘s depictions of the types of people who work at and run investment banks are better than you will find almost anywhere else, with the possible exception of the side characters in American Psycho. This is especially true for Paul Bettany, Penn Badgley, Simon Baker, and Jeremy Irons.

More importantly, the film does an excellent job showing how an investment bank might operate during a crisis and how financial contagion could be transmitted into a firesale. In this case, the assets being dumped were the highly-rated tranches of subprime CDOs.

The U.S. housing market peaked in early 2006 but the bonds financing subprime mortgages did not start bleeding money until mid-2007, which was why Ben Bernanke felt comfortable testifying to Congress that “the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained” in March of that year.

This chart shows the price changes of several indices that correspond with the value of subprime CDO tranches:

As you can see, the A tranche, which ought to have been incredibly safe, lost nearly 30% of its value during the summer of 2007. Chairman Bernanke felt compelled to provide reassurance by claiming that “the troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system.”

There were several reasons why all of these tranches were mis-rated. The most obvious was that the ratings agencies colluded with the mortgage securitizers. Yet plenty of banks blew up because they had kept the “juiciest” tranches for themselves with the expectation that this would boost their returns. Needless to say, they were wrong. They had been undone by a bad equation.

This was alluded to in the film but never explained. Fortunately, Felix Salmon wrote an excellent article for Wired magazine for those who want the details. The takeaway is that banks thought they could accurately determine the probability that a given mortgage loan would default based on the limited historical data available to them. As a result, they ended up taking far more risk than they thought they were by holding mortgage assets on their books.

In Margin Call, this is discovered by an ex-rocket scientist lured to the Street by its outrageous pay packets (Zachary Quinto). When he informs his bosses, they are faced with a dilemma. They could dump their assets, thus saving themselves at the expense of their clients, their counterparties, and the rest of the economy. Or they could endure some pain while maintaining their dignity and reputation. Needless to say, the unnamed firm in the film chooses survival.

While Goldman Sachs did not dump its mortgage assets all in one day, as depicted in the film, it did realize that the U.S. mortgage market was in trouble well before its peers. That was why it created a variety of investment vehicles for its clients, such as Timberwolf, that were composed of its most troubled assets. Just like in the film, the investment bank dumps its garbage into the unsuspecting arms of its willing clients. The bank survives but the clients do not.

In the film, the head trader (Kevin Spacey) worries that this will ruin the firm’s reputation as a reliable counterparty and doom their future as a trustworthy intermediary even if they do survive. He also worries about the way the firm would be villified by politicians and the press. His concerns were legitimate. Consider what happened to Goldman Sachs:



Incidentally, Sparks and Viniar were right that Goldman’s counterparties should have known what they were getting into. Almost by definition, banks only sell assets that they think will lose value. Otherwise they could keep those assets to themselves and make more money. No one should consider himself a “sophisticated investor” if he does not understand this basic principle. Yet the only people who keep suing Goldman for having been misled about Timberwolf run a hedge fund. Go figure.

More interesting than Timberwolf and its affiliated investments is what happened to the ABX market in the summer of 2007. Someone did decide to dump whatever they could as quickly as possible. Price declines of that magnitude only occur when there is a serious imbalance between buyers and sellers. The scenario presented in Margin Call seems like a reasonable representation for what must have actually happened.


About Matthew C. Klein
I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.

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